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In: Finance

(1)   Gap analysis is used to measure the direct effect of interest rate changes on bank...

(1)   Gap analysis is used to measure the direct effect of interest rate changes on bank earnings. Suppose that the interest rate has risen. If the amount of variable-rate assets of a bank is greater than the amount of variable-rate liabilities, will the net earnings of the bank increase or decrease?
If the amount of variable-rate liabilities of a bank is greater than the amount of variable-rate assets, will the net earnings of the bank increase or decrease?
(2)   Explain the duration of a security.
(3)   How is the duration of a security different from the maturity of a security?   

Solutions

Expert Solution

1. The earning of bank will INCREASE. The increase of the earning of bank will be due to higher amount of variable rate assets than the variable rate liabilities because the bank will be able to collect higher amount of interest than, repayment of interest.

The net earning of the bank is going to decrease if there will be a higher amount of variable rate liabilities because the bank will have a higher amount of short term repayment obligation in form of interest.

2. duration of a security is related to the volatility of the security in respect to the interest rate changes. it will be reflecting the sensitivity of the change in the acid pressure due to change in the interest rates.

3. Maturity of a security is related to the overall time in which the security is going to expire but duration of a security is related to calculation of the sensitivity of security prices in respect to interest rate changes.

jeff jeffy answered 1 year ago
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